VALUATION AND

TRANSFER PRICING IN LUXEMBOURG

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LEARN AND TASTE #1

WELCOME TO OUR #1 LEARN & TASTE EVENT !

The event explores the current debate and

possible implications of Valuation within

Transfer Pricing matters.

Speakers will examine the key issues and

challenges arising from the new rules in

Luxembourg.

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Muhammad HOSSEN Managing Partner,

Mazars Luxembourg

Françosi KAROLYI Tax Director,

Mazars Luxembourg

Philippe BARTHELEMY Senior Valuation Manager,

Mazars Luxembourg

Angéline GODIN Senior Tax Manager,

Mazars Luxembourg

INTRODUCTION

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WHERE WE STAND IN 2015

Regulatory context: - New Art. 56 of the Luxembourg Income Tax Law («LITL»)/new version

as from 1 January 2015; - §171 of Loi Générale des Impôts («AO») related to the

documentation; - Art. 164 LITL; - Circular LITL n°164/2 of 28 January 2011; - Circular LITL N°164-2 bis of 8 April 2011. OECD: - OECD Transfer Pricing guidelines; - BEPS Actions 8, 9, 10: Ensure that transfer pricing outcomes are in

line with value creation; - BEPS Actions 13: Re-examine transfer pricing documentation.

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TRANSFER PRICING AND VALUATION : BROTHERS TO

RECONCILE

Valuations can be seen by the buy and sell side as a pure intrinsic exercise (fair value of the whole or a part of a business)

where

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Market value is the price agreed for the transaction (arm’s length value)

In a transfer pricing context, only arm’s length (market) value is

considered

ARM’S LENGTH PRICE VS FAIR VALUE: COMPARISON

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Arm’s Length

(Market)

Fair Value

(Asset)

Subject transaction As actually structured As actually structured

Application context Dual perspective Single perspective

Comparable

transaction Actual Hypothetical

Valuation Arm’s length range Highest and best use

principle

SO WHAT ?

Head Office

Financing SPV’s

• Analyzing transfer prices is a question of finding which actual comparable data are applicable (if any).

• It requires a sound understanding of the business models in application into the scope of analysis.

• Basically in Luxembourg, we can break down the business model into 3 categories*

* Overlaps and combinations of

course exists

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THE BUSINESS OF FINANCING

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INTER-COMPANY LOAN

• Prior to 2015, in inter-company financing activities, the spread between the interest rates used had to be documented.

• Since early 2015, both interest rate and spread are to be documented and must be in an acceptable range.

• Local tax authorities and BEPS requirements else TAX RISK.

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Company 1

LU Financing Co

Company 3

Interest in

Interest out

Interest in < spread < interest out

TP CIRCULAR REQUIREMENTS

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APA to be obtained from Tax

Authorities (ie. decision binding Tax

Authorities for 5 years)

Economic substance Organizational substance

•Capital at risk should be effectively at

risk;

•Such capital should be equal to 1% of

nominal amount of outgoing loan or to

EUR 2M (alternative criteria).

•Majority;

•Knowledge and capacity;

•Resources;

•Key decisions in Luxembourg;

•Bank account;

•Compliance;

•Should not be considered as tax

resident in another State.

TP Methodology /

TP Documentation

Requires

TP TECHNICS TO USE - THE SPREAD

Services remuneration

• Transactions: below EUR 100 M;

• Expected result in line with the approach followed

for higher amounts;

• TP methodology: TNMM;

• Expressed as a mark up on related financing

costs.

Handling fee

• Transactions: above EUR 100M;

• Comparability analysis (e.g. qualitative and

quantitative adjustments);

• TP methodology: CUP;

• Expressed as basis points on the nominal

amount.

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Service remuneration: the most appropriate method to calculate

handling fee is the cost plus (transactions below EUR 100 M);

Equity: CAPM.

Service remuneration: cost plus (exception) / bid-ask spread;

Equity: Subordination premium / return on equity / dividend

capitalization method.

HOW TO TREAT INTER-COMPANY TRANSACTIONS

Methodology:

• Step 1: Identification and analysis of each component of the agreement: (start and end date, country of the borrower; purpose of the transaction, currency, interest rate, guarantee, subordination repayment terms and amount)

• Step 2: Determine the credit quality of the borrower (by estimating the risk of default by the borrower using the database of the credit rating agencies)

• Step 3: Perform benchmarking analysis and adjustments if needed

(with Loan Connector – deal scan or Bloomberg)

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TYPICAL IC TRANSACTIONS TO BE DOCUMENTED

Relating fees

Guarantee fees - definition

- “Commitment by a [guarantor] to reimburse a lender if a borrower fails to repay a loan.”

(OECD);

-Amount charged by the guarantor, usually as a percentage of an associated sum but

sometimes as a fixed fee;

-The terms and degrees of legal enforceability of credit guarantees differ; these differences

can have a significant impact on their pricing:

- Fromal guarantee,

- Keep well agreement,

- Comfort letter,

- Implicit parent guarantee.

Date Titre de la présentation 13

Relating fees

Guarantee fees – charge or not to charge?

- Is there a benefit?;

- “the question whether an intra-group service has been rendered (…) should depend on

whether the [guarantee] provides a group [company] with economic or commercial value

(…). This can be determined by considering whether an independent enterprise in

comparable circumstances would have been willing to pay for the [guarantee].” (OECD).

Guarantee fees – Benefit approach

-Under the benefit approach, a taxpayer estimates the benefit, in terms of reduction in

interest rate, that the guarantee provides, relative to not receiving the guarantee;

-Price of credit guarantee = estimated arm’s length interest rate without guarantee –actual

interest rate with guarantee;

-But:Should the benefit be split, so that both parties involved benefit from the guarantee?!

Guarantee fees – Consequences

- Increased enquiries and tax audits are expected in this area;

-Companies should be extremely cautious when using the assumption of implicit support

when establishing an inter-company financial transactions.

Date 14 Titre de la présentation

TYPICAL IC TRANSACTIONS TO BE DOCUMENTED

Relating fees

Factoring fee

-Under a factoring agreement a company sells or assigns its accounts receivable to a

factor in exchange for a cash advance. The factor typically charges interest on the

advance plus a commission;

-Recourse (borrower assumes the risk) or non-recourse (factor assumes the risk).

Commitment fees

-A fee lenders charge their borrowers for unused credit.

Date 15 Titre de la présentation

TYPICAL IC TRANSACTIONS TO BE DOCUMENTED

COMMON PITFALLS IN IC TRANSACTIONS ANALYSIS

In practice:

• No stand alone credit rating of the borrower (including related parties);

• Using one interest rate for all transactions;

• Using one page as a loan documentation;

• No addressing FX risks.

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THE BUSINESS OF FUND MANAGEMENT

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MANAGEMENT COMPANIES IN LUXEMBOURG

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Investment

fund

Investors

General

Partner

Advisory Co

SPV SPV SPV

Service

fee

Management

fee

FEE STRUCTURING

• The taxable basis at the level of the GP resulting from the difference between the management fees/performance fees and the service/advisory fees should be limited to an arm’s length remuneration to be documented;

• CUP would be the preferred method, however in practice there is no relevant data and information available on the basis of which the mark-up of the activity could be compared regarding the management services;

• The cost plus method would fit to the characteristics of the transaction,

however, due to the lack of the financial data in details (ie. lack of gross level financial data), this method cannot be applied either;

• Therefore, we have estimated that the selected method is the transactional net margin method (“TNMM”), which operates in a manner similar to the cost plus or resale price method, but examines the net profit to a suitable base;

• The question is whether the management fees/performance fees need to be documented No if the GP and the Fund does not qualify as “associated entity”.

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TAX COMPLIANCE ASPECTS

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TAX COMPLIANCE ASPECTS

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• Spread must be reflected in the accounts;

• In case of insufficiency of remuneration, adjustment of the taxable basis is

required (in form 500);

• In case of excess result (higher accounting result compared to the

remuneration documented in the TP report), then no adjustment downwards;

• If documented by TP study, downwards adjustment on interest free loan

possible;

• In case of retroactive documentation (as from 1/1/2012), no adjustment of the

spread of the former years in the last tax returns to be filed (e.g. no possibility

to adjust in the 2015 TRs the shortfall of remuneration related to previous

years) but instead to contact the tax controller to re-file the TRs concerned.

Latest news:

• Tax Authorities are currently sending request for documenting B2B situations

which are not covered by TP report;

• Based on a Tax Authorities internal note, it seems that TRs including B2B

activity not documented by TP report would be rejected.

Q&A AND WINE TASTING SESSION

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